Why Work More?

Professor Clites teaches economics at St. Mary’s College in Winona, Minnesota.

Practically all governments have enacted a tax on incomes that is generally termed the “progressive income tax.” I prefer to call it the “stair-step tax.” The tax is structured so that each additional increment of income is taxed at a higher percentage than were the previous ones.

Usually opponents of such a tax discuss the harm it does in terms of how it reduces capital investment and thus retards economic growth. When I was a young university instructor in the 1950s, however, I came across what may be a more easily understandable example of the damage done by this stair-step tax.

A man I knew was by far the best salesman at his company. By hard work and his ability to educate potential customers about how his firm’s products met their needs, he sold more than three times as much as any other salesman. In fact, while he worked he sold enough to keep 30 production employees busy.

Note the phrase, “while he worked.” In the 1950s our stair-step income tax reached a far higher percentage than it does today. The top rate was over 90 percent. That’s right, if your income was already high enough and you earned another dime, you didn’t get to keep a whole cent!

The salesman was paid on commission, and he decided that it wasn’t worth his while to continue working when the additional dollars he earned were taxed at a rate of 50 percent or more. He would rather take an extended vacation.

Therefore, about two-thirds of the way through each year, generally in late August or early September, he would ask his supervisor for a leave of absence until the following January. The company didn’t like to do without its best salesman for the last third of the year, but felt that giving him a leave of absence was better than taking the chance of losing him.

The consequences of the salesman’s reaction to the “soak the rich” tax structure are interesting. The salesman himself wasn’t seriously hurt. He would, as he put it, spend much of the remainder of the year at Miami Beach “watching the scenery walk by.”

Those most hurt were the 10 people who weren’t employed by the company because of his decision to not work during the last third of the year. Since he sold enough products to provide work for 30 production workers but restricted his selling time to about two-thirds of the year, he brought in only enough orders to keep 20 production workers busy. Consequently, 10 fewer people were employed.

Thus, the tax collector’s greed backfired in several ways. Since the salesman didn’t work for a third of the year, he probably paid less in total taxes than he would have had he been taxed at a lower rate but on an income that would have been about 50 percent higher.

The 10 people who weren’t employed may have wound up with little or no income to tax. In fact, they may have become a drain on the tax revenues that other people paid.

Thus, the tax collector’s greed caused a loss of revenues from two sources, and it likely added a drain on the public treasury. But, remember, those most hurt by the “soak the rich” policy were not “the rich.” They were the 10 people who weren’t employed.

THE FREEMAN

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December 2014

Unfortunately, educating people about phenomena that are counterintuitive, not-so-easy to remember, and suggest our individual lack of human control (for starters) can seem like an uphill battle in the war of ideas. So we sally forth into a kind of wilderness, an economic fairyland. We are myth busters in a world where people crave myths more than reality. Why do they so readily embrace untruth? Primarily because the immediate costs of doing so are so low and the psychic benefits are so high.